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Bitcoin: bubble or quit

Bitcoin: bubble or quit

Are you tempted to invest in Bitcoin? It has no underlying value, no fundamentals. All we have to go by is supply and demand. We know that the demand is growing. Who controls the supply? There is no real asset, no fiat and no mechanism of control. It exists because someone willed it to be so. It continues to exist and grow in value, because others perceive it to have value.


Regular beer gatherings move inevitably to discussion of Bitcoin. This week, a friend told us that he had invested R250k in June. In his lucky world, this was an amount he was prepared to lose. To gamble with: a calculated risk. His reason? He wanted to learn by experience how the world of cryptocurrency works. The gamble has paid off so far. He showed us his e-wallet: R965k (Monday 4 December). His argument was not for cryptocurrency, but for blockchain technology. He is also investing in the tech.


I asked him why he did not now take his initial R250k out, to safeguard his initial investment, to trade on his winnings alone. His answer: he could afford losing the initial amount, even the million rand it now represents, and leaving it in would simply add to the learnings and earnings. Great. I dissolved quietly into my beer.


This guy has over two decades in finance and investments, is a natural sceptic, qualified to comment and has money. He has built an investment portfolio which includes a (proportionately small) high-risk component. He has made a calculated investment in a platform, not a product. But is he the norm? Unlikely. Most people “getting in” are doing so late, and don’t have a quarter of a million to burn. They are joining the herd, and it is running.


Bruce Whitfield made the case against Bitcoin compellingly in his column in Business Times this week past [1]. Bubble; and not a currency at all. His view coincides with Nobel laureate Joseph Stiglitz, and numerous other luminaries, including Warren Buffett. Stiglitz, interviewed by Bloomberg TV, says it “ought to be outlawed” [2]. Bill Gates, Richard Branson and Elon Musk appear somewhat cagey, even rambling, in their supposed defence of Bitcoin [3]. At best, they are indifferent. Proponents of cryptocurrency may be invoking their names in vain. Meanwhile, the herd keeps running and growing.



Herds and bandwagons
We tend to follow the herd, even if we don’t think we do. Our decision-making seldom occurs in isolation. “Implicitly or explicitly, consciously or unconsciously, the social context influences choice” [4].


Herding is something we do as a species, aligning our actions whether as individuals or in groups, but without any specific centralised coordination[5]. We tend to follow the crowd, even if there is no guiding coalition or obvious leader. We can consider this a form of social conformity. Neuroscientific studies have shown that this behaviour follows principles of reinforcement learning[6]. Our brains like to conform. Our brains tell us not to disagree; “…an automatic response to deviating behaviour from others makes it difficult for consumers to resist such an influence” [7].


That explains the bandwagon effect and it applies to Bitcoin, “where the herd instinct leads to certain types of mass trading behaviour and actions”[8]. We go with the majority. The herd activity leads to short-term changes in the price of the (crypto)currency. “The inherent problem is that the occurrence, frequency and potential effects of these events are…difficult to predict”[9]. In other words, we will follow the herd, even if it crashes into the ravine.


Consumer decision-making
So, do people only invest in Bitcoin because everyone else does? Of course not, but we validate our decision bias in the safe and sure comfort of the herd. In this case, several biases and fallacies combine[10].


First, we are overconfident. We overvalue our own competence or judgement. Expert opinion is divided on Bitcoin, but the herd is confident it knows better. Just like it did with tulips in the Netherlands in the 1700’s, or ostrich feathers in SA a century ago. What is more, we are overconfident in our ability to time the market. We know that there is a risk of this bubble bursting. Like dread disease, we just don’t think it will happen to us.


Second, we are subject to illusory correlation, seeing a spurious cause-effect relationship. In this case, between Bitcoin’s price and blockchain as an evolving technology trend. The fact that blockchain is set to shake up the tech market is one thing. Ascribing inherent and directly attributable value to just one by-product of that technology is quite another.


Thirdly, and possibly most significantly, we are falling into the trap of the hot hand fallacy: that because some independent event happened in the past, the pattern will continue in other independent events in the future. We believe a team on a winning streak will continue to win, for instance. As there are no underlying fundamentals to the price of Bitcoin, there is no more reason to believe the price will rise than fall tomorrow. What pushed the price up? Appetite. And if appetites change tomorrow, say the launch of a new and sexier cryptocurrency, or one underpinned by a commodity or fiat currency? There are already over a thousand cryptocurrencies, and calls for a EuroBit. Maybe the BoE launches a ChainPound, or the Fed releases a DollarBlock. Who knows?


Then there is the heuristic of satisficing. We are limited by our bounded rationality. We consider options one by one until we find one that meets our minimum level of acceptability. Then we stop searching. We look for ways to make money, every day. Something comes along that seems to represent easy money, in a tough economy. And it is global, and based on technology that challenges the traditional banking system. We stop looking for other alternatives. We buy into the dream. The big bonanza. We remember the game-changers that went before that we didn’t get in on early: Apple, Google, Facebook. The problem is that we stop asking ourselves the tough questions, in this case about fundamentals and underlying value, and plausible alternatives.


Finally, there is the hindsight bias. This is a form of memory distortion. We look back at what has happened, knowing the outcome, and believe that we knew in advance what the outcome would be. This applies to those now invested in Bitcoin: “I got in early”. And it will apply when the bubble bursts: “I always knew it was a bubble” followed by some level of justification.


Maybe we can reduce these to a simpler bias. One we know from popular culture today: FOMO. The fear of missing out. But consider another heuristic: if it seems to be too good to be true, it usually is.


Genius mistake
Whitfield references Sir Isaac Newton’s having invested in the South Sea Company in the 1720’s. He withdrew early, made a tidy sum and then came back in late again. He was drawn back in by herd mentality, and FOMO, as his friends who remained invested got wealthier. Alas, it was the Ponzi scheme of the day, and it collapsed. He lost. He wrote the book on mathematics, and yet he jumped on the bandwagon[11]. Whitfield ends with the quip, that one of the smartest people ever to live, and the one who described gravity, should have known that “what goes up, must come down”.


Maybe that friend will lose his R965k, and maybe he doesn’t mind. But he could have learned the same lesson with R2 500 instead of R250k. He is a smart guy, but so was Isaac Newton. The herd continues to thrum itself into a frenzy, not paying attention to the tall grass.



    1. Whitfield, B. 2017. If it looks like a bubble and it acts like a bubble…

Sunday Times Business Times

    1. , 3 December:11


    1. Bloomberg. Sn. https://www.bloomberg.com/news/videos/2017-11-29/joseph-stiglitz-bitcoin-ought-to-be-outlawed-video


    1. https://www.youtube.com/watch?v=1sOC_1DPtrc


    1. Yoon, C, Gonzalez, R, Bechara, A, Berns, GS, Dagher, AA, Dube, L, Huettel, SA, Kable, JW, Liberzon, I, Plassman, H, Smidts, A & Spence, C. 2012. Decision neuroscience and consumer decision making.

Mark Lett

    1. , 23:473-485.


    1. Rafaat, RM, Chater, N & Frith, C. 2009. Herding in humans.

Trends in cognitive sciences

    1. , 13:420-428.


    1. Klucharev, V, Hytonen, K, Rijpkema, M, Smidts, A & Fernandez, G. 2009. Reinforcement learning signal predicts social conformity.


    1. , 61:140-151.


    1. Yoon et al


    1. Kodongo, O & Ojah, K. 2011. Global monetary systems and foreign exchange markets, in

Global business environments and strategies

    1. , edited by Aregbeshola, A, Luiz, J, Ojah, K, Oostuizen, T, Palmer, P & Venter, P. Cape Town: Oxford University Press: 163-184.


    1. ibid


    1. Sternberg, RJ & Sternberg, K. 2017.

Cognitive psychology

    1. . Boston: Cengage: 441-459


    Even though the Bayes’ theorem would only be presented to the Royal Society 36 years after Newton’s death in 1727, probability theory was being discussed among mathematicians from the early 1700’s.